Larry's VC View is the bi-weekly blog by photonics entrepreneur and budding venture capitalist Dr. Larry Marshall who shares his thoughts and reflections on the VC scene, as he makes the transition from serial entrepreneur and engineer, to Venture Capitalist. He hopes to share his experiences, lessons and mistakes with fellow entrepreneurs seeking venture funding.

Monday, March 24, 2008

I wanted to respond to some of the posts and questions, so I will do that in this BLOG and post “The deal that died” next time. Please keep the questions coming, or propose new BLOG topics, it really helps me focus on what’s important to you.

Joyce said … Hey Larry - what are your top tips for crossing the chasm? Also, how can I persuade engineers that one or two Evangelist Clients does not guarantee commercial success (without demotivating them)?

I always liked Geoffrey Moore’s chasm talk – he’s the only guy I know who can whip through 75 slides in 20 minutes ;-) we had a great breakfast a few years back (at Il Formation) … this is what I learned:

The early adopter is the heart and soul of your initial marketing process – without them there is likely no real business. They have to value your technology (unlikely you have a real product at this stage) way beyond the money. They need to see clearly the unfair advantage that they can gain with you and be willing to put up cash to validate it. Often they will pay NRE to craft the technology into the product that they critically require – particularly in hardware companies. They will pay a premium to get the unfair advantage to grow their market. They will tolerate all types of problems, provided you properly set their expectations because they share your vision of what could be. Beware the tire kickers who are price sensitive and skeptical who can trash your “product” and stifle your growth – pay them no mind at this phase because you are simply not ready for prime time yet. Now, Joyce is right, you will start to kid yourself that you have made it because these evangelists love your technology and you are making “sales” – but the fact is, what you are really doing is developing your product and crafting your marketing, and sales processes – these are just as critical (and just as much processes) as product development. It gets very scary when you run out of early adopters because suddenly sales evaporate, and you don’t know where to go next except down into Moore’s Chasm.

If the early adopters are properly mined, then you have the beginnings of marketing – these early customers can become evangelists who will be your best initial sales force – if you have chosen correctly these people will be respected and followed by the mass market and even the skeptical customers will start to pay attention to you. Beware, you don’t get second chances with the skeptics – so make sure your product is solid, and you understand the sales process. Your early adopter who should have helped you navigate thru the internal process of their company so you have the beginnings of a sales process, the touch points, the decision makers – can you close a skeptic? Your sales process will need to morph as you learn and you will iterate many, many times, but you will develop the process and ultimately use it to win more and more customers.

I want to use Adrian, as an example here – he sells chip level software (more like hardware to me). Now Adrian tried shooting elephants, but they are hard to down, so after a while he learned that shooting squirrels is much easier and after a while he secured about 80 such customers, albeit smaller order sizes. Seeing this proliferation, his early adopter customers got even more excited and took him to their internal skeptics in other operating divisions who ended up signing near-exclusive agreements to use only his product across all their product lines. He broke from small volume early adopters, to mainstream mass market in about two years. Don’t be discouraged – it takes a lot of squirrels before you are ready to bag an elephant. I’ll write a BLOG on this soon.

Anonymous said … Can you write your next blog about great entrepreneurs going to the dark side?

So meet my buddy F who was a great product manager in telecom – he rolled out some of the most successful products in the early days (pre-bubble) of optical networking. A couple of years prior to the Internet and subsequent telecom boom, F saw what was coming and raised $45M to fund a revolutionary kind of optical transport company. Actually, initially he went to senior management and tried to convince them that this product would dramatically grow their business, but they were unable to see his vision. So F founded his first startup. He was funded by a dear friend of ours, who, during the telcom boom, was the most successful general partner at one the top three Sand Hill Rd venture firms.

In two years, his company had built a revolutionary new type of optical transport system and it was with great pride that he walked into his board meeting in early 2000 with an offer to acquire the company……for $1B…..!?! Now I still remember clearly his excitement at the offer, followed by astonishment at his board’s rejection of it – imagine $45M invested, $1B exit in just two years – it was unprecedented. What on earth was his board thinking? To quote one of the leading VCs at the time, “it’s not enough.”

Now many of us have been through this experience, very few at this price level, but many at far lower prices – and the shock of rejecting a perfectly good offer generally compounded into deep regret because the later offers (especially in 2001 and 2002) were far, far lower, or non-existent.

So F went back out into the market, continued to build his business, and later that year sold it … for over $3B!!! I guess this time, it was enough. With such a stellar return he was invited to become a partner at one of the leading firms, but decided, in a very entrepreneurial way, to control his own destiny, do his own investments and be a part time venture partner there. After a while, he took over a venture fund for a large corporation, and after making that fund good returns, he joined one of the rising stars in venture firms and continues to make great investments.

So what does F say about his journey? The hardest thing was realizing that he wasn’t an entrepreneur any more, i.e., he couldn’t do it all himself – he had to become a coach not a player, he had to learn to let the entrepreneurs do it themselves without jumping into every sales situation and deal and taking control. One of the characteristics I always notice when he hears a pitch, is that he stops the entrepreneur from diving into the story, and makes them talk about themselves – he has that uncanny entrepreneur’s instinct of judging character and will often get to know the entrepreneur for half of the initial meeting. It puts many entrepreneurs off (especially those who get embarrassed talking about themselves, i.e., mostly Aussies ;-)), because they want to talk about their products and companies.

F tells me he can make the general decision to invest simply from that first half-hour of getting a feel for the character and historical experience of the entrepreneur. He also is a great believer in first-time CEOs, not just because he was one, but because of their unique characteristics (discussed in an earlier BLOG). The other great characteristic that F has, is the ability to help the entrepreneur, in most cases strengthening their plan by seeing flaws in it that he himself has experienced. In a later Blog, I’ll try to get permission to tell Milton’s story, who is the most successful entrepreneur turned VC I know, but he’s pretty humble and won’t like publicizing himself. The other one is Kevin Kalkhoven, who took JDSU from a small OEM laser supplier to the largest optical component supplier in the world, then rolled over his gains to set up KPL ventures.

Mudmaps said … So Larry - tell us why you want to be a VC now? And why VCs want entrepreneurs in their ranks?

The other VC I wanted to mention in entrepreneur-to-VC transition was Dado Benato who founded Tallwood after building a very successful semiconductor company, and then doing a stint at Mayfield as a VC. Most VCs in Silicon Valley come from the ranks of entrepreneurs. I know that in other places VCs are often bankers, especially from private equity, but not here. Its scary being on the other side of the table, because I always thought it was hard to raise money from VCs, but never appreciated how positive and optimistic they are compared to limited partners, from whom VCs must raise their money ;-)

I think six startups is enough, and it’s time to help other startups get funded, and be successful. In 2005 I took a group of US VCs down to Australia, when that government was reviewing the venture ecosystem. Often it’s best for governments to get advice from independents who have no local political agenda. I’ve been in the US for 20 years this year, and I was shocked at the changes in my country. I saw a substantial unfulfilled need, and like any entrepreneur, an opportunity to fill it. I like many VCs, I also have had some bad experiences with them – I would like to be a different kind of VC, and I think there is a better chance of succeeding at that being a serial entrepreneur. Now, there’s a lot I don’t know (and I’m discovering more every day!) but VCs are supposed to add more than just money to their investee companies – that’s why they want serial entrepreneurs in their ranks.

Dado spends a day a week companies he is invested in and on the BoD of – his success metrics are exceptional. When asking for advice on how to be a better VC, one answer I got was this – “I don’t think the term VC is a meaningful term – your fund is a startup, like the companies you invest in. Focus on being a good entrepreneur for that startup and you’ll succeed; and if you do ever work out what a VC really is, please let me know” – I think that’s great advice for all of us ;-)

Monday, March 10, 2008

In the midst of a major bear market, with global economies faltering and a worldwide credit crunch, it’s hard to see the future--I just witnessed a record one-day point drop on Asian markets and saw 12 IPOs cancelled indefinitely.

A couple of years ago I was starting the first day of a roadshow and the front page of the nation’s major financial paper read “Biggest one-day point drop since 911.” When it turns it turns fast. Everyone runs for the exit but there is no sign of an exit. It’s an ill wind that blows no good for someone. Let’s be realistic, some investors made far more on the 2000 market crash than most made on the rise--shorting stocks and the beneficial tax consequences created massive wealth for many--though not me unfortunately ;-).

For entrepreneurs, economic downturns can be good. Obviously if you are in the middle selling or IPO-ing your company, then it’s bad, but if you are fund raising it can be exceptionally good. Of my six startups, all but one was founded in either a recession or significant economic downturn--these are great times to start companies inventing and/or developing products that will come onto the market in a year or two. Established competitors are downsizing and slashing R&D to appease a falling market, while you are investing venture dollars on a far longer timescale than next quarter.

In a recession, everything is cheaper--employees are better and easier to recruit, materials are more available, and suppliers are eager to help you if you have money ... so how do you get money in a recession? It’s clearly not a great time for bootstrapping (unless your friends and family have nerves of steel)—it’s human nature to think the sky is falling once markets slide, and everyone fears for their future. Think back to 1999 and the ease of raising capital; 20 companies were funded in the same space when five years before two would be lucky to launch.

Unfortunately the size of the market didn’t really support 20 startups, and customers used the abundance of competition to drive down prices and force most of those startups out of business. Ironically, when the so called tech wreck hit, funding stopped and many companies hit the wall especially in internet and telecom. However, new areas won big, and many VCs kept investing – cleantech was born, solar cell companies were founded, and social networking found its beginnings.

It’s true that many VCs downsized their funds from $1 B to $0.5 B but they kept investing, this time in a manageable number of deals. Seven years later, VC funding has finally exceeded its 2000 peak--will there be a pullback similar to equity markets and real estate? Sure, but it wont stop, simply the quality of investments and entrepreneurs will get better. If you have a great idea, and a market exists in the two-year time frame, you will get funded, and by the time you come to market today’s bear will be a bull again.

A corollary to this “timing is everything theme,” is, when they pass the hors d’oeuvres, make sure you take two--I have never met the CEO who saved his business by avoiding dilution, but I know a lot who went through bankruptcy proceedings because of failing to raise sufficient capital. If you waste too many cycles on negotiating a term sheet trying to angle a better deal, the market can move past you and you end up with nothing.

VCs can be predatory in bad times, but they also get preyed upon in good times--if you can find an investor who will treat you fairly, and you believe you can build a strong long-term relationship it’s often a good long term decision to give on valuation in favor of the intangibles. You will be together for a long time, and markets will undoubtedly get bad at some point in your relationship--a good foundation and history can often carry you through when others fail … and sure, your VCs can help too ;-)